Have Earnings Peaked? | Podcast

Have Earnings Peaked?

August 11, 2021

Episode Description
FEATURING Charles Toole and Steve Johnson

Is this as good as it gets for earnings growth? Nearly every name in the S&P 500 has exceeded analysts’ expectations again this quarter, with the average beat more than 17%. Are these brilliant numbers just a paper façade? Or do they indicate real strength in the economy? This week, Portfolio Managers Steve Johnson and Charlie Toole discuss what’s behind the flashy headlines. Topics include:

  • How much of the earnings boom is due to the “base effect
  • The surprising resurgence of last year’s darlings, large-cap tech stocks
  • Whether record-high profit margins are sustainable
  • The sectors that are still suffering from the pandemic’s effect

The stock market has climbed to some dizzying heights over the past year. Will the delta variant finally trip it up? Charlie and Steve analyze the prospects. Click above to listen now and learn more!

Episode Transcript

Steve Johnson:

With almost 90% of companies reporting earnings that have beat estimates and with markets at all-time highs, have we reached peak growth? Well, listen to Portfolio Manager Charlie Toole and me as we explain the second-quarter earnings, what it means for the market and what it may mean for the quarters ahead.

Charlie Toole:

Hello, and welcome to another The Adviser You Can Talk To Podcast. I’m Charlie Toole and I’m joined today by Steve Johnson. Steve, how are you doing today?

Steve Johnson:

I’m great, Charlie. Thanks for having me.

Charlie Toole:

Thank you for being here. We are the co-managers of the dividend income strategy and we’re here again to talk earnings. Our team has been busy over the past few weeks reading earnings releases and listening to management teams on earnings conference calls. In this podcast, we’ll talk about the major themes that we’ve been reading and hearing about. Let’s jump right in. Steve, some numbers to start with. Nearly 90% of the S&P 500 have reported earnings for the second quarter so far. And according to FactSet, earnings are nearly 90% higher than they were at this time last year. Only Q4 of 2009, going back to 2008, has a higher quarterly growth rate—or year-over-year growth rate—at 109%. It’s a bit of a loaded question, but is this as good as it gets for earnings growth?

Steve Johnson:

You know, Charlie, we could have said the same thing last quarter. But remember, during the second quarter of 2020, earnings were dismal because of the pandemic. So this year made easy comparisons. Plus you have to give the economy credit; it has recovered strongly. Companies have been able to report better-than-expected earnings. In fact, Charlie, you’re talking about beating earnings—the average company has beat those earnings by 17%. It just goes back to how accurate the analysts really haven’t been. But again, there is strengthening in the economy, we’re coming off of very easy comparisons and so companies have been able to be very successful in recording these earnings.

Charlie Toole:

And that’s a good point going back to last year, because I think the companies that we’re seeing that are leading the charge have been the companies that were hit hardest last year. Whether it’s casino companies and leisure companies, energy companies, consumer discretionary companies, retail—these are the areas that we’re seeing the biggest beats and the best revenue growth.

Steve Johnson:

You’re exactly right. I mean, it’s to be expected, right? If you’re Las Vegas Sands or Wynn Resorts, clearly your business shut down last year during the pandemic. So you’ve been able to record enormous growth year-over-year as you’ve reopened. The other theme, Charlie—we’ve been talking about this, I think it seems like a broken record—but we’ve just also seen enormous revenue in sales growth from the large tech companies. Right? You’ve seen the largest percent increases from the likes of Wynn and Las Vegas Sands, but we’ve seen the greatest dollar increases from large-cap tech. Amazon, Apple, Microsoft—just again showing incredible growth year-over-year. That’s been a theme that’s been consistent now for the last couple of years.

Charlie Toole:

Right. And what makes the growth of those three tech companies in particular impressive is that unlike other companies that struggled a year ago, those tech companies were actually thriving in the work- from-home, stay-at-home environment. That makes their growth rates all the more impressive. Shifting gears a little bit, I do want to talk about profit margins. We’ve talked about revenue and earnings being higher than they were a year ago, but companies are also raising profit margins or having higher profit margins. We’re tracking at about a 13% profit margin, which again would be an all-time high from FactSet going back to 2008. And really the dynamic that we’re seeing here is there’s a lot of costs related to COVID that are falling as we start to reopen and see vaccinations take hold.

Steve Johnson:

Exactly right. I think this has been the biggest surprise for analysts. As people are trying to predict where stock prices would go, everyone believed that margins would be compressed. As we thought about this, what’s the word we’ve heard for the last six months? Inflation. And on all of these conference calls we’ve heard—whether it be Pepsi, which talked about the impact of their earnings next year because of freight costs and because of input costs—we’ve heard it from Kimberly-Clark and Procter & Gamble. But despite the issues with input costs, companies outside of consumer staples, such as technology, industrials and energy, have seen their margins increase. When we look at technology companies, you look at industrials, you look at energy, all of those sectors have benefited—to your point about COVID costs coming down.

Steve Johnson:

They’ve had a lot of leverage coming into this as well, if you think about it; the U.S. consumer has had a lot of stimulus. While they’ve been at home, their incomes have actually gone up. It’s allowed them to really pay higher prices. So companies have been able to pass those costs along. I guess to your earlier question, though: Is this as good as it gets? Well, we’ll see. But it does seem that these profit margins—it would seem hard for them to remain elevated at this level.

Charlie Toole:

Right. And we mentioned the drop in COVID costs, but there are other costs that have started to come back, like marketing spending, and some costs that have yet to come back, like business travel. You’re not seeing business travel get back to areas or to levels that were pre-pandemic. And it’s probably not likely. That pivots, I think, to our next point. Really, the one area that hasn’t come all the way back is travel. I mentioned business travel not picking up. Visa and MasterCard, they track what’s called cross- border transactions. Those are transactions in different countries from where you’re domiciled. Those are basically people making transactions when they travel. And those cross-border transactions are only at 50% of what they were pre-pandemic. Whether it’s a delta variant or vaccination levels that internationally aren’t as high as they are in the U.S., you’re not seeing that international travel pick back up—where you are seeing it on the domestic side.

Steve Johnson:

Exactly. And Charlie, we haven’t even talked about the delta variant. These companies reported during the second quarter—everything was reopening. Everyone was going back out to eat. They were traveling. They haven’t seen people in a year or two. Now, all of a sudden, as we’ve seen over the last month—we track things like OpenTable and count reservations and, as you mentioned, the spending numbers—and we’ve seen them plateau and actually slow down. The question is, for the third quarter, anyways: Yes, we have seen travel increase, but with this delta variant, will we start to see people be a little bit reluctant to go back out again? Will we start to see dining slow down? Will we start to see that spending slowdown from that peak that we saw perhaps in the second quarter?

Charlie Toole:

All right, Steve, I’m glad you brought up the delta variant because a lot of the data that we’re talking about today was reported and commented on by management teams before the delta variant really took off in the United States. And I think we saw management teams guide conservatively. Of the 450 or so companies in the S&P 500 that reported earnings, only 71 issued guidance for the next quarter. Management teams were very conservative in even forecasting what might happen in the next three months. Maybe they foresaw the delta variant, or maybe they foresaw something else, but we saw management teams steer, or err, on the side of caution.

Steve Johnson:

It’s a great point, Charlie, because if you look—yes, 60% of the companies issued positive guidance, yet there’s still quite a few, 29 out of those 71, that issued negative guidance. As you mentioned, there are a variety of factors, and it goes back to your earlier point about is this peak earnings? You’ve seen the inflation pressures that people have seen throughout the quarter. We’ve also talked about perhaps wage increases. We’ve talked about an increase in the minimum wage. We’ve really talked about perhaps the economy maybe reaching its peak here. Companies—this is as good as it gets for them. So a lot of these companies are, to your point, a little bit hesitant. As we’ve talked about—Pepsi, for example—they said earnings may be impacted up to 70 cents next year by all of these different costs. Perhaps they’re hedging, perhaps they’re sandbagging for next year, but clearly they are setting the bar a little bit lower because of all of these unanticipated factors that we’re witnessing.

Charlie Toole:

Right. And costs get into the last topic that I wanted to bring up. This was a topic that we talked about last quarter, and we’ll probably talk about it again next quarter. It’s really the dynamics of inflation, supply chain disruptions, and specifically semiconductor or chip shortages. I think you had already mentioned consumer staples companies like Pepsi, Procter & Gamble, Kimberly-Clark talking about price increases, labor, high labor turnover or just struggling to find workers, which is something that companies like McDonald’s have mentioned. And then chip shortages have impacted companies from Apple to Intel and even some industrial companies. This is something that we’ve talked about a lot— inflation being transitory or these supply chain disruptions being transitory—but it is still having a material impact on a lot of the earnings of these companies.

Steve Johnson:

Yeah. I can’t imagine being a CEO right now because it is so hard to predict, I think, their business going out six months in normal times, and now you have all of these factors. Whether it be the supply chain issues, wages now and labor shortages that they’re having to deal with. But I will say, what we have seen recently is that a lot of the fear of inflation—we’re starting to see some of those prices come down. We’ve seen lumber down almost 70% from its high. Iron ore down 30%. Oil’s down 15% from the high. There is a sense, I believe, that perhaps we are seeing the peak readings in inflationary pressure that may make it easier for some of these companies as they go forward. The other part of that is a lot of these companies have been able to pass on these price increases.

Steve Johnson:

We were listening to Procter & Gamble’s call when they were talking about some of their leading cleaning products—the Swiffer, for example. They’re implementing a double-digit price increase beginning in September. As you know, once you pass those along, it’s pretty hard to—if you’re the CEO—to bring them back. For now, consumers have paid these higher prices because they’re flush with stimulus and incomes have gone up.

Steve Johnson:

The question is: In September, we know that those stimulus checks are going to be ending. Now we’re going to go back to perhaps a more normal recovery, more normal economy. Will consumers be willing to pay up for those goods, for those higher-quality goods that are a little bit more expensive? If they’re not, and companies start seeing their sales decline in the fourth quarter and the first quarter, what will that do to earnings? I think that’s a variable that we don’t know yet—whether or not the consumer stays strong. But that will go a long way to determining what those earnings will be and whether or not these companies will be able to maintain these higher prices.

Charlie Toole:

Steve, I think that’s a great spot to end it. Thank you for joining me today. I think the big takeaway from our conversation is that corporate profits are still growing, but growth rates in the second quarter are probably going to peak and continue to decline, although still remain positive. We’ll continue to keep an eye on supply chain constraints and how this impacts corporate profits and inflation. This has been Charlie Toole and Steve Johnson from Adviser Investments, thanking you for listening to The Adviser You Can Talk To Podcast. If you enjoyed this conversation, please subscribe and review our show. You can check us out at adviserinvestments.com/podcasts. Your feedback is always welcome. If you have any questions or topics that you’d like us to explore, please email us at info@adviserinvestments.com. Before closing, I’d like to thank Ashlyn Melvin. She makes this podcast happen by doing all the complicated technology that Steve and I have no clue how to work. Thank you, Ashlyn, and thank you for listening.

Podcast released on August 11, 2021. This podcast is for informational purposes only. It is not intended as financial, legal, tax or insurance advice even though these topics may be discussed. Information and events addressed in this podcast, as well as the job titles, job functions and employment of the podcast’s participants with respect to Adviser Investments, LLC may have changed since this podcast was released. For more information on each individual featured in this podcast, see the Our People section of our website.

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We’re starting to see prices come down. Lumber is down almost 70% from its high…There’s a sense that we’ve seen the peak of inflationary pressure, and that may make it easier for some of these companies as they go forward.


Stephen Johnson, JD, CFP®, CPWA®

Vice President, Portfolio Manager

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